Solving the Goldilocks Problem: A Market Based Proposal for a More Efficient Feed-in Tariff in Japan

During the midday hours of May 25, 2012, Germany accomplished an impossible task: nearly fifty-percent of the energy generated in the country came from solar power.[1] Humming along at twenty-two gigawatts, Germany’s solar power plants pumped out electricity with the force of twenty nuclear power stations.[2] Germany’s stunning achievement came with unsustainably high, incentive-based costs. Just over one month later, on June 28, 2012, the German legislature approved cuts to their solar incentives program to prevent costs from spiraling out of control.[3]

Germany maintained an incentive program known as a feed-in tariff through which utilities pay energy producers certain published prices, called tariff rates, for energy.[4] The feed-in tariff incentivized development of solar generating capacity by providing solar producers a special tariff rate (price per kilowatt-hour) above the prevailing electricity market rate.[5] The higher tariff rates guaranteed the solar developer a profit.[6] Utilities that bought electricity at the higher rate recouped the additional expense by passing on the cost in higher electricity bills to ratepayers: the homeowners, businesses, and governments that use the electricity.[7]

Setting an appropriate tariff rate is a critical decision. Incentives that are too low result in minimal solar development, and incentives that are too high heavily burden the ratepayer by driving up their costs[8] and risk creating a bubble.[9] In essence, this is a Goldilocks problem: the incentives cannot be either too high, or too low; they must be just right. To prevent the risk of setting prices too high, the German legislature changed the law to lower these payments and safeguard the program’s sustainability.[10] The legislature’s reaction to the emerging problem succeeded, and Germany currently maintains a robust solar incentive program.[11] As a result, Germany continues to be a global leader in solar energy development in terms of total installed capacity and annual installations.[12]

A similar incentive program in Spain did not fare as well. Although the Spanish incentive scheme also led to a rapid boom in solar development, policymakers failed to respond to the incredible increase in solar generation.[13] The increase in solar generation was unaffordable and economically unsustainable.[14] The government responded by not only limiting the program in the future, but also by retroactively reducing tariff rates that had been promised to solar developers in binding contracts.[15] A bust quickly followed the boom.[16]

Japan is now following in the footsteps of Germany and Spain. Following the meltdown at Fukushima, Japan sought to diversify its energy sources without relying too heavily on fossil fuel imports.[17] To accomplish a transition away from nuclear power while maintaining a desirable import-export balance, Japan’s legislature created a solar feed-in tariff to spur solar development.[18] The tariff succeeded in sparking a large quantity of solar development, but the law does not self-regulate costs.[19] This means that much like in Spain, and in Germany’s initial laws, Japan’s tariff does not automatically respond to market forces by reducing the subsidy amount as the solar market grows. [20] Although the law permits for a tariff adjustment, this adjustment depends on action from the Ministry of Economy, Trade and Industry, rather than automatically reducing based on the occurrence of an event like reaching certain benchmarks for capacity installed.[21] The current process is unpredictable for the market and risks causing a boom-bust cycle similar to what occurred in Spain. Instead, Japan should alter the law to automatically reduce the tariff as certain benchmarks are met. These benchmarks could move either up or down as installations wax and wane with the changes in market conditions. This responsive policy has the potential to achieve Japan’s goals of increased solar energy development more efficiently.